Personal Taxes and Corporate Cash Holdings

Abstract

Dividends are taxed at the personal level, but injecting funds into firms does not offer the symmetric tax benefit. Hence, there is a tax saving incentive to retain cash in the firm. We develop a corporate finance model of liquidity management, in which the firm's liquidity policy trades off precaution and saved personal taxes against agency and corporate tax costs. The model implies that the tax saving motive is substantial and increasing with the dividend tax rate. Consistent with the model, we empirically show that affected firms reduce their cash accumulation after a dividend tax cut.

Keywords: Dividend Tax; Capital Gains Tax; Cash holdings; Agency Costs; Tax Savings Motive

JEL Classification: G32; G35; G38; H24; H32; K34